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Don’t fall into these traps when accounting for stock-based compensation

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If you work at a startup company or have startup clients, you know all too well that cash can be tight and hiring and retaining top talent is a challenge. 

In response many startups turn to equity compensation to attract and retain top talent without breaking the budget on salaries and benefits. Stock-based compensation also ties employees to the company’s success as they essentially become owners. Employees will theoretically work harder and think twice before leaving if they have a chance to earn a substantial windfall in exchange for taking a below-market starting salary.

Great. But founders and their financial teams must remember that equity compensation is not free — it’s a form of deferred compensation that must be treated as an expense. As such, equity compensation has strict rules and regulations for employers and employees to follow, especially regarding taxes. 

Even with substantial financial backing, many private/early-stage companies do not have enough resources to handle complex GAAP accounting and financial reporting for SBC awards. This can be problematic since larger investors or banks typically want a third party to sign off on the accuracy of the startup’s financials. They want assurances that the company is not doing anything fraudulent or failing to follow GAAP guidance. Also, being careless with SBC in your company’s early years can make it very costly and time-consuming to change from non-GAAP to GAAP standards as you prepare for an IPO, sale or other exit.

Setting the table

One of the top requirements is to determine fair market value for the company’s stock through a 409(a) valuation, which is required for tax compliance and necessary before optioning or issuing stocks. Typically, startups will need to undergo the 409(a) valuation once per year and any time after they raise funding. Companies should also provide reasonable guidance to employees about the tax consequences of various types of equity compensation. That’s very important since some employees, particularly young workers, have never received equity compensation before. When restricted stock awards provide ownership interest upon vesting, the 83(b) election allows these awards to be taxed at the grant date based on their FMV — even if they have not fully vested. By making an irrevocable 83(b) election within 30 days of the RSA grant, employees recognize taxable income immediately without waiting for vesting. This strategy can be beneficial if the stock’s value is expected to rise, since it minimizes ordinary income and maximizes capital gains upon sale. However, employees and their advisors should be cautious because taxes paid via this election are non-refundable if the RSA does not vest, or if its value declines. Generally, paying tax upfront is advantageous when the stock’s value is lower.

Five things that founders and financial teams often overlook regarding equity compensation

1. Being too generous: Founders might want to understand various types of share-based payment awards, such as stock options, restricted stock awards, restricted stock units, etc., that best align with the company’s expected growth and strategies. They might unintentionally give out too many shares in employee equity plans without taking into account long-term equity dilution. Without careful planning, founders could inadvertently allow employees to receive more financial benefits than the company planned for in a liquidity event. Also, the founders might not have enough shares to give up in later rounds of financing.

2. Vesting criteria too easy to meet: Share-based payment awards come with various vesting conditions, with a plain vanilla plan being a four-year service vesting requirement without other performance conditions or without taking market conditions into account. Founders and their financial teams may want to provide employees with additional conditions if the vesting conditions are easy to achieve. Otherwise, key employees might leave the company much sooner than expected. I’ve found over my career that the easier the vesting conditions, the less motivation employees tend to have to perform at a high level and attrition rates rise.

3. Vesting criteria too aggressive: Conversely, if the employer wants to make vesting more stringent or restrictive, it can add conditions such as EBITDA targets or IPO/change in control, which are considered performance conditions, or multiple of invested capital, which is a market condition. Stock-based compensation awards serve as incentives. Vesting conditions should be challenging enough to drive employees toward meaningful, but not unrealistic, achievement. If vesting goals are set too high, the awards may lose their motivational effect, working against their primary purpose of aligning employee efforts with company success.

4. Inconsistent record keeping: The executive team sometimes underestimates the amount of effort required to maintain legal documents, the cap table, vesting and exercising schedules. Good recordkeeping is crucial when the company goes through financial statement audits or financial due diligence. Without proper recordkeeping, financial statement audits and due diligence processes can be significantly prolonged. This can trigger higher audit and diligence fees, delays in closing the transaction, and even risking deal termination or substantial penalties (see the cautionary tale below).

5. Tax implications: The founders might overlook potential implications of income taxes and payroll taxes varying depending on the types of awards. Understanding the main differences between incentive stock options and non-qualified stock options is essential when creating equity incentive plans.

Accounting challenges regarding common forms of equity compensation

Startups frequently use equity compensation (e.g., stock options, restricted stock units, etc.), but many fail to grasp its accounting complexities. ASC 718 requires companies to recognize the FMV of these awards as an expense. Complexities arise with performance-based or market-based conditions, which require careful classification and tracking. Accountants must ensure that awards (liability or equity) are properly classified and they must monitor modifications that could lead to additional expenses.

Misclassifying these instruments above can result in misstated financial statements, which is especially problematic during audits or liquidity events (e.g., M&A, IPO). Failing to account properly for embedded derivatives or misclassifying equity and liabilities can lead to noncompliance with GAAP, potential penalties and loss of investor confidence. 

Cautionary tale

One of our startup clients initiated their first financial statement audit to prepare for a Series A capital raise. They expected to complete the audit within eight to ten weeks, which is typical for companies with adequate staffing and strong internal controls. However, the audit dragged on for over a year due to significant recordkeeping issues. The company lacked a cap table, despite issuing multiple classes of preferred equity, stock options, restricted stock units, restricted stock awards, convertible debt, SAFEs and warrants. Some equity awards had even been granted without board approval. Reconstructing the cap table required extensive time from the management team, causing substantial delays.

After completing the cap table, the company engaged a third-party consultant to determine the appropriate accounting treatment for these equity instruments under ASC 718, ASC 480 and ASC 815 — a process that took additional weeks. In the tighter capital environment of 2022 to 2024 marked by higher interest rates, the company ultimately failed to secure the necessary working capital to sustain operations. Furthermore, due to poor recordkeeping, the company was required to amend prior-year tax returns, resulting in hefty penalties.

This case underscores the importance of maintaining accurate records and clear internal controls to avoid costly delays and risks during audits and capital-raising efforts.

Equity compensation is one of the most important tools startups have for preserving cash flow and retaining top talent. As a CPA, you play a critical advisory role in ensuring the company accounts for these instruments correctly, reducing the risk of costly restatements and ensuring compliance during future liquidity events. The startup culture runs fast and furious with constant pivots and reiterations. Don’t let proper treatment of equity compensation get lost in all the excitement. That’s where you come in.

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Accounting

Tax Fraud Blotter: Crooks R Us

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The shadow knows; body of evidence; make a Note of it; and other highlights of recent tax cases.

Newark, New Jersey: Thomas Nicholas Salzano, a.k.a. Nicholas Salzano, of Secaucus, New Jersey, the shadow CEO of National Realty Investment Advisors, has been sentenced to 12 years in prison for orchestrating a $658 million Ponzi scheme and conspiring to evade millions in taxes.

Salzano previously pleaded guilty to securities fraud, conspiracy to commit wire fraud and conspiracy to defraud the U.S., admitting that he made numerous misrepresentations to investors while he secretly ran National Realty. From February 2018 through January 2022, Salzano and others defrauded investors and potential investors of NRIA Partners Portfolio Fund I, a real estate fund operated by National Realty, of $650 million.

Salzano and his conspirators executed their scheme through an aggressive multiyear, nationwide marketing campaign that involved thousands of emails to investors, advertisements, and meetings and presentations to investors. Salzano led and directed the marketing campaign that was intended to mislead investors into believing that NRIA generated significant profits. It in fact generated little to no profits and operated as a Ponzi scheme.

Salzano stole millions of dollars of investor money to support his lavish lifestyle, including expensive dinners, extravagant birthday parties, and payments to family and associates who did not work at NRIA. He also orchestrated a separate, related conspiracy to avoid paying taxes on his stolen funds.

He was also sentenced to three years of supervised release and agreed to a forfeiture money judgment of $8.52 million, full restitution of $507.4 million to the victims of his offenses and $6.46 million to the IRS.

Marina del Rey, California: Tax preparer Lidiya Gessese has been sentenced to 41 months in prison for preparing and filing false returns for her clients and for not reporting her income.

Gessese owned and operated Tax We R/Tax R Us and Insurance Services from 2013 through 2019 and charged clients $300 to $800. Gessese would then prepare returns that included claims to deductions and credits she knew her clients were not entitled to, including falsely claiming dependents, earned income credits, the American Opportunity Credit, Child Tax Credits, business deductions, education expenses or unreimbursed employee business expenses. The illegitimate claims led to some $1,135,554.64 issued by the IRS for 2010 through 2018.

She failed to report, or underreported, her own income for 2010 through 2018, some of which included improperly diverted funds from clients’ inflated or fraudulent refunds, causing a tax loss of $488,276.

Gessese, who pleaded guilty in April, was also ordered to pay $1,096,034.01 to the IRS and $53,526.95 to her other victims.

Fullerton, California: In Chun Jung of Anaheim, California, owner of an auto repair business, has pleaded guilty to filing false returns for 2015 to 2022, underreporting his income by at least $1,184,914.

He owned and operated JY JBMT INC., d.b.a. JY Auto Body, which was registered as a subchapter S corp. Jung was the 100% shareholder.

Jung accepted check payments from customers that he and his co-schemers then cashed at multiple area check cashing services; the cashed checks totaled some $1,157,462. Jung withheld the business receipts and income from his tax preparer and omitted them on his returns.

He will pay $300,145 in taxes due to the IRS and faces a $250,000 penalty and up to three years in prison. Sentencing is Jan. 31.

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Tucson, Arizona: Tax preparer Nour Abubakr Nour, 34, has been sentenced to 30 months in prison.

Nour, who pleaded guilty a year ago, operated the tax prep business Skyman Tax and for tax years 2016 through 2018 prepared and filed at least 27 false individual federal income tax returns for clients.

These returns included falsely claimed business income that inflated refunds so that he could pay himself large prep fees. Nour’s clients had no knowledge that he was filing false tax returns under their names.

Nour was also ordered to pay $150,154 in restitution to the United States for the false tax refunds.

Farmington, Connecticut: Tax preparer Mark Legowski, 60, has been sentenced to eight months in prison, to be followed by a year of supervised release, for filing false returns.

From January 2015 through December 2017, Legowski was a self-employed accountant and tax preparer doing business as Legowski & Co. Inc. He prepared income tax returns for some 400 to 500 individual clients and some 50 to 60 businesses.

To reduce his personal income tax liability for 2015 through 2017, Legowski underreported his practice’s gross receipts by excluding some client payment checks. He then filed false personal income tax returns that failed to report more than $1.4 million in business income, which resulted in a loss to the IRS of $499,289.

Legowski, who pleaded guilty earlier this year, has paid the IRS that amount in back taxes but must still pay penalties and interest. He has also been ordered to pay a $10,000 fine.

Wheeling, West Virginia: Dr. Nitesh Ratnakar, 48, has been convicted of failing to pay nearly $2.5 million in payroll taxes.

Ratnakar, who was found guilty of 41 counts of tax fraud, owned and operated a gastroenterology practice and a medical equipment manufacturer in Elkins, West Virginia. He withheld payroll taxes from employees’ paychecks and failed to make $2,419,560 in required payments to the IRS. Ratnakar also filed false tax returns in 2020, 2021 and 2022.

He faces up to five years in prison for each of the first 38 tax fraud counts and up to three years for the remaining counts.

Orlando, Florida: Two men have been sentenced for their involvement in the “Note Program,” a tax fraud.

Jasen Harvey, of Tampa, Florida, was sentenced to four years in prison and Christopher Johnson, of Orlando, was sentenced to 37 months for conspiring to defraud the U.S.

From 2015 to 2018, they promoted a scheme in which Harvey and others prepared returns for clients that claimed that large, nonexistent income tax withholdings had been paid to the IRS and sought large refunds based on those purported withholdings. The conspirators charged fees and required the clients to pay a share of the fraudulently obtained refunds to them.

Overall, the defendants claimed more than $3 million in fraudulent refunds on clients’ returns, of which the IRS paid about $1.5 million.

Both were also ordered to serve three years of supervised release. Johnson was also ordered to pay $864,117.42 in restitution to the United States; Harvey was ordered to pay $785,858.42 in restitution. Co-defendant Arthur Grimes will be sentenced on Jan. 13.

Ft. Lauderdale, Florida: Tax preparer Jean Volvick Moise, 39, has been sentenced to three years in prison for filing false income tax returns.

Moise prepared false returns for clients to inflate refunds. He prepared returns which included, among other things, false dependents, false 1099 withholdings, false educational credits and false Schedule C expenses, often for businesses which did not exist. Moise’s fee was larger than the typical one charged by a tax preparer.

Moise filed hundreds of false returns that caused the IRS to issue more than $574,000 in fraudulent refunds.

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Accounting

Accounting in 2025: The year ahead in numbers

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With 2025 almost upon us, it’s worth thinking about what the new year will bring, and what accounting firms expect their next 12 months to look like.

With that in mind, Accounting Today conducted its annual Year Ahead survey in the late fall to find out firms’ expectations for 2025, including their growth expectations, their hiring plans, their growth expectations, how they think tax season will play out and much more. The overall theme: Thing are going well, but there are elements of friction holding them back, particularly when it comes to moving to more of a focus on advisory services.

You can see the full report here; a selection of key data points are presented below.

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Accounting

On the move: Withum marks over a decade of Withum Week of Caring

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Citrin Cooperman appoints CIO; PKF O’Connor Davies opens new Fort Lauderdale office; and more news from across the profession.

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